Optimal fuel taxation with suboptimal health choices

Abstract

Transport has a large number of signi cant externalities including carbon emissions, air pollution, accidents, and congestion. Active travel such as cycling and walking can reduce these externalities. Moreover, public health research has identi ed additional social gains from active travel due to health bene ts of increased physical exercise. In fact, on a per mile basis, these bene ts dominate the external social costs from car use by two orders of magnitude. We introduce health bene ts and active travel options into an optimal taxation model of transport externalities to study appropriate policy responses. We characterise the optimal second-best fuel tax analytically: when physical exercise is considered welfare-enhancing, the optimal fuel tax increases. Under central parameter assumptions it rises by 49% in the US and 36% in the UK. This is due to the low fuel price elasticity of active travel. We argue that fuel taxes should be implemented jointly with other policies aimed at increasing the uptake of active travel to reap its full health benefi ts.